March 01, 2018

THIRD PARTY FUNDING DISCLOSURE ISSUES – AN ARBITRATOR PERSPECTIVE

Remarks presented by Marc J. Goldstein in the lecture program of AAA/ICDR practice moot in New York on February 23, 2018. 

 Introduction

The CEO of a third-party funding firm in New York is an exceptionally capable attorney who was a colleague of mine at my former law firm. He was not just another colleague; we worked together on major international arbitration cases. One of them, as it happens, was a very early instance of the use of third-party funding — used by our client, and negotiated with the funder by a funding neophyte named Marc Goldstein, for a sizeable claim against a state-owned entity — in that instance, a Singapore-seated arbitration against a ministry of the People’s Republic of China. Having a client funded by a funder, in a large firm disputes practice circa 2000, was déclassé to put it mildly. It implied that your practice, and your firm, were going down-market in search of business, in search of a firmer foothold in the world of    international  arbitration. How the world has changed.

Today, if my former colleague’s funding firm is providing funding for the Claimant in an arbitration in which I am appointed as an arbitrator – and especially if I am the Claimant’s party-appointed arbitrator – this is a fact that all parties might wish to know and have the opportunity to consider at an early stage, from the standpoint of whether the my appointment might be challenged, and whether the award might be in jeopardy if the matter goes undisclosed and is uncovered, say, by investigators for the award loser. It follows that the funding facts are facts that the arbitrator might prefer to know, and to consider for potential disclosure, so that there should be no serious question raised later on about the arbitrator’s independence and impartiality.

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Role of IBA Guidelines

Students involved in the Moot will surely have read carefully and considered the relevant sections of the IBA Guidelines on Conflict of Interest in International Arbitration 2014. The arbitrators present in the room surely are familiar with them, but perhaps only a fraction of them have had to consider applying the guidelines to their own disclosures in an arbitration, or to a party’s application to the Tribunal for disclosures by the adverse party, when the applicant expressed a concern that the adversary’s case is funded by a Funder.

If a funded party volunteers a disclosure that it is funded, the arbitrators can take guidance from the IBA Guidelines —in essence analyze potential disclosures in regard to the Funder as if the Funder were a party —make suitable disclosures, make suitable follow-up inquiries to the disclosing party to enable the arbitrator to conduct due diligence. An ICC Guidance Note issued in 2016 is to similar effect. The problem of course is that voluntary disclosure of funding is not universal and probably is not even common; it is not mandated by institutional rules, or by industry self-regulatory measures, or, in all but a handful of important host jurisdictions for international arbitrations, by applicable law. Notably there is a mandate for disclosure in the arbitration provisions of the new Canada-EU Trade Agreement. And if you happen to have an investment arbitration under the Singapore Centre’s 2017 investment arbitration rules, it is explicitly stated in those rules that the Tribunal has power to order such disclosure by a party. But as to mandatory disclosure, Singapore in amending its arbitration law to permit third party funding  did not enact a mandate broadly — but did enact such a mandate as a Rule of Professional Conduct for Singapore attorneys.

If a party in an arbitration suspects or knows that its adversary is funded, as is the case in the Moot Problem this year, the IBA Guidelines, if adopted as guidelines by the Tribunal as is so commonly the case, give the arbitrators guidance on what the Tribunal may require – by a procedural order, for example — in terms of disclosure from the party that is, or is suspected to be, funded by a Funder. But that useful function of the Guidelines does not assist participants in the arbitration in sorting out the possible relationships between an arbitrator and a Funder, and the bearing of those relationships on the arbitrator’s eligibility to serve, at the critical early stage of nomination and appointment. In our Moot Problem this year, the problem surfaces very early on in the proceedings, but after the Tribunal has been constituted.  An urgent question that still troubles our community, and on which no consensus of approach has emerged, is how shall we tackle this problem at the earliest stage, when the administering institution, or perhaps an appointing authority in an ad hoc case, is collecting information relevant to the arbitrator’s eligibility to serve and sharing that information with the parties.

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Framework for a Institutional Mandatory Disclosure Rule

In the few minutes I have before you return to battle, I would like to do three things. First, let’s try to list some relationship concerns an arbitrator may have about Funders – concerns that the parties may have about the arbitrator. Second, let’s look at the some of the key reasons why Funders (and maybe their funded clients) push back against the idea of mandatory initial disclosure. Third, let’s look at what the basic elements of a mandatory initial disclosure scheme might look like.

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 1.  Concerns About Arbitrator Relationship With Funders

  1. Funder role in arbitrator’s selection?
  2. Arbitrator’s affiliation with Funder. (“Investment Adviser”)?
  3. Fellow arbitrator affiliation with Funder (Sitting as chair nominated by …)
  4. Funder is/was funding the cases arbitrator is or was handling as counsel
  5. Arbitrator’s prior appointments by other parties funded by same Funder (to extent known)
  6. Funder funding cases being handled by other lawyers in arbitrator’s firm
  7. Funder is providing “portfolio finance” to arbitrator’s (present or former) firm
  8. Arbitrator’s  former colleague now employed by Funder
  9. Arbitrator pitched case(s) to Funder & was turned down.
  10. Possible arbitrator relationships with the Funder’s funders (e.g. hedge funds, venture capitalists, )
  11. Arbitrator’s knowledge of Funder’s reputation for exacting due diligence
  12. Arbitrator’s knowledge of Funder’s reputation as newcomer eager

2.    Objections Voiced Against Mandatory Disclosure

One main objection voiced by some Funder spokespersons against mandatory disclosure is that the terms of the funding arrangement are confidential between the parties and irrelevant to the arbitration. To this objection I would say that the terms of the arrangement may or may not be relevant at some stage of the arbitration, such as when a motion is made for security for costs. But at the initial stage when the objective is to enable the arbitrator to unearth and disclose to an appropriate degree her connections to the Funder, the terms of the funding arrangement should not usually be of consequence. Why not limit disclosure to the fact of funding and possibly the identity of the Funder, and see where that goes? There seems to be a consensus gathering around such limitation —indicated in ICCA-Queen Mary Task Force comment draft issued September 2017.

A second objection of some Funder-affiliated persons to mandatory initial disclosure is that such disclosure raises a suspicion if not an assumption, at least for the adverse party, that the funded party is impecunious and not financially capable on its own of satisfying an eventual, possible, award for costs should the non-funded party prevail. The stated concern is that arbitrations will then be routinely encumbered with costly and contentious motions for security for costs, and also with an ever greater number of vexatious challenges against arbitrators. These concerns are genuine. But they should be manageable. The solution of addressing them by suppressing the very fact of funding and identity of the Funder seems quite overbroad. Funders systematically do, and will continue to, publicize the fact that many of their clients are not impecunious but are very solvent entities that opt for funding as a cash management and risk management tool. And funded parties who must face down security for costs applications will continue to advocate the emergent rule that mere impecuniousness of the party is not alone a sufficient basis for a security for costs order unless there is other evidence of the party’ s unwillingness to satisfy such obligations and its avoidance of such obligations on other occasions. And institutions will readily adopt efficiency measures as needed to process arbitrator challenges relating to third-party funding.

A third objection, voiced by certain prominent Funder spokespersons, is that no disclosure mandate should be imposed on Funders who are in what may be called the private equity model, while omitting other Funders, such as insurers and direct equity investors in or commercial lenders to the funded party.  Failure to be inclusive would be discriminatory, it has been claimed. Perhaps the strategy of this objection is to fend off mandatory disclosure for as long as possible by prolonging debate on definitions. Or perhaps the nub of this objection is that traditional insurance has not been thought of as raising a potential conflict of interest situation for the arbitrator, and that the private equity mode of Funder should be seen in the same way. But if you look at the list of concerns reviewed above, I submit that the range and seriousness of concerns about arbitrator independence and impartiality does not arise nearly as often when the Claimant or Respondent merely has insurance coverage. The ICCA-Queen Mary Task Force Report, at least in the 2017 comment draft, seeks to address the objection by including insurers in the proposed disclosure standard. Perhaps that is the solution providers should adopt — it means more due diligence work and more disclosure and perhaps more unmeritorious challenges. But if that is the price to be paid for broader market acceptance of a disclosure rule covering the Funders we are mainly concerned about from a conflict perspective, then the wider definition of Funder seems a price worth paying.

I will ask you now to permit me to speculate on what may be a key but unarticulated source of the Funders’ reluctance toward a rule of mandatory disclosure. I would speculate that the more prominent is a Funder, the larger its investments in cases and potential returns, the more the Funder is staffed by highly skilled disputes lawyers with extensive international arbitration experience, then the greater will be the influence of the Funder in the selection of arbitrators. This influence may be more pronounced when the funded party has engaged counsel who are not regular players in international arbitration and who may not be particularly well-informed about the community of arbitrators and the relevant selection criteria.  I would speculate that Funders have preferred arbitrator lists just as law firms do. And over time perhaps the firms that maintain such lists may conform their lists to those of the Funders that fund them. And I would speculate, in turn, that such preferred arbitrators would more often face resistance to their service, by a non-funded party, if it emerged that, while the arbitrator has had no other cases in recent years for either the Claimant or the Claimant’s law firm, he or she is currently sitting in seven cases funded by the Funder.

The logic of the Funding business would tell us that this should be the case, because the selection of the arbitrator should logically be for the Funder, as it usually is for the Party, one of the most if not the single most critical arbitration planning decision. For the party that decision is framed as how to proceed. For the Funder it will affect whether to proceed at all. Confidentiality among Funders, parties, and law firms makes it difficult to measure objectively the scope of Funder influence in arbitrator selection.

So there may well be a giant Elephant In The Room — Funder influence over arbitrator selection — whenever we discuss third party funding in an open forum like this, even when a Funder representative is not on the program. And perhaps the presence of that Elephant explains why, with some of the exceptions earlier noted, initiatives for mandatory disclosure has failed to gain traction within the institutional framework of international arbitration. Repeat appointments of arbitrators by the same law firm are a well-known issue. Systematic repeat appointments of the same arbitrator by the same Funder probably could not long survive in a mandatory disclosure environment.

3.    A Possible Mandatory Disclosure Rule in Operation

Whether there should be mandatory disclosure of the identity of the Funder is perhaps a question that deserves more attention. Funders have market identities, and they burnish them. Some of them engage prominent arbitrators and retired judges as “investment advisers.” Some of them boast of how selective they are in identifying cases to be funded (although this is somewhat diminished as larger Funders move to a portfolio finance model). If the Funder’s identity potentially carries with it a sort of endorsement of the funded party’s claim (or defense), arguably the identity of the Funder is information the arbitrators should receive only on a need-to-know basis. But there is a price to be paid: to determine if the arbitrator needs to know the identity of the Funder, the arbitrator would need to make disclosure, to the institution, of a complete list of Funders with whom she or her firm have connections. The institution could then determine if there is a “match,” and often there would not be, and the conflict check process would end there, with the identity of the Funder protected. But the arbitrator, especially the arbitrator affiliated with a large firm, will have done quite a bit of information gathering. This is a cost-benefit calculus that would need to be made, in promulgating a mandatory disclosure protocol in institutional rules.

In the protocol outline that follows, I will assume that the calculus is made in favor of shielding the arbitrators from the identity of the Funder unless there is a need to know:

  1. Filing party informs institution whether it is funded and if so identifies to the institution the Funder and Funder’s material investors.
  2. In a funded case, the institution will submit to the arbitrators a questionnaire calling upon the arbitrators to disclose to the institution the identity of the Funders (i) in past or pending cases as arbitrator where the Funder was identified, (ii) in past or pending cases of arbitrator’s firm as counsel, (iii) from which arbitrator’s firm sought or maintained funding in last X number of years, (iv) with whom the arbitrator has or in last X years had other relationships with Funder such as Board member or consultant, and (v) with whom the arbitrator has present or meaningful past professional or personal relationships with officers/employees of Funders.
  3.  If no match, then the parties would be informed that the arbitrator’s responses to the questionnaire reveal no matters for potential disclosure, and therefore the identity of Funder will not be disclosed to Tribunal as there is no need.
  4. If there is a match, the arbitrators would be notified of the identity of the Funder and invited to make disclosures as they deem appropriate. The parties would be notified that the Funder has been identified to the arbitrators. This conveys to the parties only the bare fact of some connection between one or more of the arbitrators and the Funder, and leaves to the arbitrator the discretion to determine in the first instance whether the connection amounts to a matter for which disclosure ought to be made.

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Having now outlined this proposal let me conclude by telling you why this may not work, why institutions that administer international arbitrations  could be loathe to adopt it. The providers obviously are in competition for cases, and any one of them considering to be a pioneer in mandating disclosure risks having major law firms flee from their rules at the urging of their Funders. Maybe, then, Singapore is on the right track in making a disclosure mandate into a rule of professional conduct for lawyers. Perhaps we will see lawyer disciplinary bodies around the world being urged to follow Singapore’s lead in the years to come.

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